1. Deciding whether or not to open a new store is part of the process known as:
A) Capital budgeting.
B) Credit management.
C) Capital structure.
D) Cash management.
E) Working capital management.
2. . The total market value of the firm’s equity is determined by _______________.
A) the corporate treasurer
B) the firm’s financial manager
C) the firm’s stakeholders
D) the firm’s stockholders
E) regulatory authorities
3. Which of the following are disadvantages of the partnership form of ownership?
A) Personal liability and double taxation
B) Personal liability and limited firm life
C) Double taxation and limited firm life
D) Ease of formation and unlimited firm life
E) Ease of formation and ease of ownership transfer
4. Which of the following is generally true regarding liquidity as it relates to the firm?
A) Liquidity is detrimental to a firm because it allows the firm to pay its bills more easily, thereby avoiding financial distress
B) Liquidity is valuable to a firm because liquid assets can be sold quickly without much loss in value
C) Liquidity is valuable to a firm because a firm can borrow money using its liquid assets, such as a warehouse, as collateral
D) Assets are generally listed on a firm’s balance sheet in the order of increasing liquidity
E) Liquid assets generally earn a large return, especially in comparison to illiquid assets
5. An income statement _____________________.
A) measures performance as a snapshot on a specific date
B) prepared according to GAAP, will show revenue when it accrues
C) excludes accrued taxes payable
D) includes expenses only when they are ultimately paid off in cash
E) is an accurate representation of a firm’s net cash flows
6. Suppose you have the 2003 income statement for a firm, along with the 12/31/2002 and 12/31/2003 balance sheets. How would you calculate net capital spending?
A) Ending net fixed assets (2003) minus beginning net fixed assets (2002) plus 2003 depreciation
B) Beginning net fixed assets (2002) minus ending net fixed assets (2003) plus 2003 depreciation
C) Beginning net fixed assets (2002) plus ending net fixed assets (2003) minus 2003 depreciation
D) Ending net fixed assets (2003) minus beginning net fixed assets (2002) plus 2003 taxes paid
E) Ending net fixed assets (2003) plus beginning net fixed assets (2002) minus 2003 taxes paid
7. The net change in cash over a period of time is equal to
A) cash uses plus operating cash flows
B) additions to current assets minus expenditures on fixed assets
C) net income plus depreciation, minus taxes and dividends
D) ending cash minus changes in long-term debt minus additions to fixed assets
E) cash flow from operating activities plus net cash from investment and financing activities
8. The financial manager of Gothic, Inc., tells her banker that Gothic’s accounts receivable declined by $275,000 that day. Based on this, the bank knows that Gothic’s current ratio:
A) Must have increased from the day before.
B) Must have decreased from the day before.
C) Did not change from the day before.
D) Declined but the quick ratio was unchanged from the day before.
E) Would possibly be affected, but more information is needed to know in which direction.
9. Which of the following is (are) a measure of long-term solvency?
A) Total debt ratio
B) Cash coverage ratio
C) Price-earnings ratio
D) Two of the above
E) All of the above
10. In creating pro forma statements, if we assume that costs, assets, and short-term debt vary directly with changes in sales, that the payout ratio is fixed, and that the change in long-term debt only results from payments made as required on the debt contracts, then the item required for the balance sheet to balance will probably be:
B) Total debt.
C) Long-term debt.
D) New equity sales.
E) Retained earnings.
11. If total assets increase by the same percentage as sales increase,
A) it is likely assets and sales will increase by identical dollar amounts.
B) the larger the increase in sales, the more likely there will be a need for external financing.
C) the firm is assumed to be operating at full capacity.
D) B and C are correct.
E) None of the above.
12. Total assets divided by sales is called the _____ ratio.
A) Capital intensity
B) Return on assets
C) Capital budgeting
D) Total asset turnover
E) Interval measure
13. Which of the following combinations of attributes would make a capital expenditure project desirable to a financial manager?
I. The project is worth more to the firm than the cost to acquire it.
II. The value of the cash flow generated by the project exceeds the project’s cost.
III. The project’s cash flows have acceptable levels of risk and size, but not timing.
A) I only
B) I and II only
C) I and III only
D) II and III only
E) I, II, and III
14. Kay purchases a $100, 30-year annuity. Kam purchases a $100 perpetuity. In both cases, payments begin in one year, and the appropriate interest rate is 10%. What is the present value of Kam’s payments that will occur from year 31 onwards?
D) More than $100
15. The Buckeye Co. needs $14 million to finance a new project. The company plans to issue new shares of common stock at a price of $19 per share to fund this project. The underwriting fee is 7%. How many new shares of stock must company issue?
16. Erin has $6,000 in her investment account. She wants to withdraw her funds when her account reaches $10,000. A decrease in the rate of return she earns will:
A) Increase the value of her account faster.
B) Cause her to wait longer before withdrawing her money.
C) Cause the present value of her account to decrease.
D) Allow her to withdraw more money sooner.
E) Cause the compounding effect to increase.
17. An account was opened with $1,000 ten years ago. Today, the account balance is $1,500. If the account paid interest compounded annually, how much interest on interest was earned?
18. Jack and Jill both want to have $5,000 in three years. Jack expects to earn 8% on his investments and Jill expects a 7% rate of return. Which one of the following statements is correct concerning the amount of money they each need to invest today?
A) Jill needs to deposit $112.33 more than Jack today.
B) Jill needs to deposit $173.33 more than Jack today.
C) Jack needs to deposit $3,699.16 today.
D) Jill needs to deposit $3,081.49 today.
E) Both Jill and Jack should deposit $3,969.16 today.
19. The principle of diversification states that spreading an investment over a number of assets will eliminate:
A) All of the risk.
B) All of the systematic risk and part of the unsystematic risk.
C) All of the unsystematic risk and part of the systematic risk.
D) Most of the systematic risk.
E) Most of the unsystematic risk.
20. Which one of the following will decrease the risk of a portfolio that consists of stocks, Canadian Treasury bills, and gold?
A) Decreasing the number of securities in the portfolio
B) Selling stocks and replacing them with Canadian Treasury bills
C) Selling a .90 beta stock and buying a 1.1 beta stock
D) Selling the gold and buying more diversified stocks
E) Selling the large-company stocks and buying small-company stocks
21. What is the expected return on asset A if it has a beta of 0.3, the expected market return is 14%, and the risk-free rate is 5%?
22. Andrew bought an 8.5% annual coupon bond at par. One year later, he sold the bond at a quoted price of 98. During the year, market interest rates rose and inflation was 3%. What real rate of return did Andrew earn on this investment?
23. Okie, Inc. has some 8% preferred stock (stated value $100) outstanding. How much are you willing to pay for one share of Okie preferred stock if you require a 7% rate of return?
24. Muon purchased 1,000 shares of Quark stock this morning at a price of $45.67 a share. The stock paid a dividend last year of $1.80 per share. Muon’s required rate of return is 13% on this type of investment. What is the capital gains yield on Quark stock?
25. The weights placed on each source of financing when computing the WACC are based on the:
A) Most recent book values available.
B) The latest book values filed with the OSC.
C) Market value of the equity portion and the face value of the debt portion.
D) Market value of both the equity and the debt outstanding.
E) Par value of the equity and the face value of the debt outstanding.
26. Which one of the following will increase the WACC of a firm?
A) An increase in the marginal tax
B) An increase in the debt-equity ratio
C) An increase in the risk-free rate of return
D) A decrease in the level of risk of a project
E) A decrease in the yield-to-maturity of the bonds
27. A proposed project lasts three years and has an initial investment of $200,000. The after tax cash flows are estimated at $60,000 for year 1, $120,000 for year 2, and $135,000 for year 3. The firm has a target debt/equity ratio of 1.2. The firm’s cost of equity is 14% and its cost of debt is 9%. The tax rate is 34%. What is the NPV of this project?
28. The internal rate of return should:
A) Not be used for ranking mutually exclusive projects.
B) Only be applied to small projects.
C) Be relied upon more heavily than the net present value.
D) Always result in the same decision as discounted payback.
E) Lead to correct decisions when comparing mutually exclusive projects.
29. Thomas’s Tank Engines is considering a project that will cost $1.2 million to start. The project is expected to produce cash flows starting in year 2 of $269,000 a year for the following six years. What is the internal rate of return on this project?
30. Texa Soil Co. purchased a tract of land last year for $1.2 million. At that time, the company spent $50,000 in legal fees to have the land rezoned for commercial use and another $175,000 to have the land graded so that it is usable. The company is now trying to decide if they want to build one large retail store on the property or a strip mall consisting of smaller stores. Which of the costs identified above should be included in the project analysis to determine the best use of the property?
A) All of the identified costs
B) Only the cost of the land and the grading
C) Only the legal fees and the grading costs
D) Only the cost of the grading
E) None of the identified costs
Section 2: Short Answer Questions/Problems (25 marks)
1. ( 2 marks) Vindaloo Corporation reported retained earnings of $400 on its year-end 2002 balance sheet. During 2003, the company reported a loss of $40 in net income, and it paid out a dividend of $60. What will retained earnings be for Vindaloo’s 2003 year-end balance sheet?
2. (2 marks) A firm has an ROA of 8%, sales of $100, and total assets of $75. What is its profit margin?.
3. (4 marks) Given the following information: profit margin = 10%; sales = $100; retention ratio = 40%; assets = $200; equity multiplier = 2.0. If the firm maintains a constant debt-equity ratio and no new equity is used, what is the maximum sustainable growth rate (SGR)? (Assume a constant profit margin.)
Hint: In short form, Sustainable growth rate = (ROE x Retention Ratio) / (1- ROE x Retention Ratio)
4. (5 marks) If your brother-in-law invests in the stock market and doubles his money in a single year while the market, on average, earned a return of only about 15%, is your brother-in-law’s performance a violation of market efficiency?
5. (4 marks) Iggie’s Used Cars will sell you a 2002 Suzuki Aerio for $3,000 with no money down. You agree to make weekly payments of $40 for two years, beginning one week after you buy the car. What is the EAR of this loan?
6. (8 marks) The Rebus Co. is trying to decide between the following two mutually exclusive projects:
The only requirement the company has is that any project that is accepted must produce a minimum rate of return of 11%.
Calculate payback period, discounted payback period, IRR and NPV, as well as any other measures which would be helpful.
Fill in the following table with your results:
Discounted Payback (yrs.)
What should the company do and why?
Section 3: Three Problems (55 marks)
Cash $ 50 Accounts payable $100
Inventory $150 Notes payable 100
Fixed assets $600 Long-term debt 350
Total assets $800 Total liabilities & equity $800
Taxes (34%) 68
Net income $132
a. Suppose that current assets, costs, and accounts payable maintain a constant ratio to sales. The firm retains 40% of earnings.
i. If the firm is producing at full capacity, what is the total external financing needed if sales increase 25%, assuming fixed assets increase proportionately with sales (4 marks)?
ii. If the firm is producing at only 90% capacity, describe how this would impact your answer. You don’t need to do a calculation, but it may help you to explain your reasoning. (3 marks)
b.. Suppose the firm wishes to maintain a constant debt-equity ratio, retains 60% of net income, and raises no new equity. Assets and costs maintain a constant ratio to sales. What is the maximum increase in sales the firm can achieve? (8 marks)
(15 marks) The managers of Magma International, Inc. plan to manufacture engine blocks for classic cars from the 1960s era. They expect to sell 250 blocks annually for the next five years. The necessary foundry and machining equipment will cost a total of $800,000 and belongs in a 30% CCA class for tax purposes. The firm expects to be able to dispose of the manufacturing equipment for $150,000 at the end of the project. Labour and materials costs total $500 per engine block, fixed costs are $125,000 per year. Assume a 35% tax rate and a 12% discount rate.
a. What is the depreciation tax shield in the third year for this project?
b. What is the present value of the CCA tax shield?
c. What is the minimum bid price the firm should set as a sale price for the blocks if the firm were in a bidding situation?
d.. Assume that management believes that auto restorers will pay $3,000 retail per engine block. What is the NPV of this project?
(25 marks) King’s Mfg. Inc. has 12,000 bonds outstanding that have a 6% coupon rate. The bonds are selling at 98% of face value, pay interest semi-annually, and mature in 28 years. There are 400,000 shares of 9% $100 preferred stock outstanding with a current market price of $83 a share. In addition, there are 1.40 million shares of common stock outstanding with a market price of $54 a share and a beta of 1.2. The common stock paid a total of $1.80 in dividends last year and expects to increase those dividends by 4% annually. The firm’s marginal tax rate is 34%. The overall stock market is yielding 12% and the Treasury bill rate is 4.0%.
a. What is the cost of equity based on the dividend growth model?
b. What is the cost of equity based on the security market line?
c. What is the cost of financing using preferred stock?
d. What is the pre-tax cost of debt financing?
e. What weight should be given to equity in the weighted average cost of capital computation?
f. What would be the cost of new financing (including the impact of each of 28-year bonds, preferred shares and common shares), assuming that flotation costs would be 5% of the proceeds of the issue?
g. If net income in the next year is expected to be $8,000,000, what would be the common equity breakpoint for new financing, assuming the current capital structure is considered optimal?